A Dividend, A Downgrade: Fitch Cuts Costco Rating

By Michael Aneiro

Here’s one possible side effect of the current special-dividend epidemic: credit rating downgrades. Shareholder-friendly uses of cash are often seen as bondholder-unfriendly, and Fitch Ratings took that view of Costco Wholesale‘s (COST) $7.00 special dividend announcement this morning, promptly cutting Costco’s rating by a notch to A+ from AA-, which is still in investment-grade territory.

Fitch cited Costco’s rising leverage as it plans to issue at least $2 billion in new senior unsecured bonds to fund part of the $3 billion in dividend payments. Costco pointed to low borrowing rates and pending tax hikes on dividend payments as reasons to pay the dividend and foot part of the bill with new debt. Costco had $1.6 billion of debt outstanding at Sept. 2.

Assuming Costco were to issue up to $3.5 billion of new bonds, Fitch said adjusted leverage would increase from 0.8x at to 1.7x and would remain in the mid-1x range over the next three years. Fitch said Costco is unlikely to issue any more debt for the foreseeable future and will use free cash flow to repay future debt maturities, the first of which comes due in 2016. Despite the downgrade, Fitch said Costco still enjoys a strong competitive position, solid operating performance and ample free cash flow and liquidity.